Short-term mitigation measures implemented by FERC in U.S. power markets have resulted in the elimination of price signals in certain parts of the country and have set in motion the “ultimate death spiral” by mitigating below the price of entry, Julie Simon, vice president for policy at the Electric Power Supply Association (EPSA), told a power industry conference last Thursday.

“The mitigation that FERC has put in place in the short-term markets have two very significant affects,” Simon told the Power Marketing Association’s “Power Markets 2003: What Works” conference in Arlington, VA.

The first impact of the short-term mitigation “is that it dampens prices significantly.” By way of example, she pointed to the automated mitigation procedures (AMP) being utilized in New York’s power market. The AMP, in conjunction with the in-city mitigation in New York City, has had the affect of lowering power prices dramatically and changing the bidding behavior of market players “so they won’t get caught up in regulatory messes,” Simon said.

“The effect is that price signals are being eliminated, and so the need for new investment isn’t being felt either by the investment side or by the demand response side,” she added. “And so what we’re seeing is a real problem that masks what’s underneath and we really can’t discount that.”

“The Commission talks about mitigated prices needing to capture a scarcity value, but they don’t. New York has basically evolved to a ‘pay as bid’ auction. They pay people [a] $50, $60 market clearing price, and then they call all of the reliability resources — they might have to pay them $300 or $400, but they never reset the market-clearing price. So you have no scarcity value being reflected in those markets.”

FERC in May approved a comprehensive mitigation plan put forward by the New York Independent System Operator (NYISO) designed to reduce the likelihood of the exercise of market power in the empire state. One element of the plan is the AMP, which drew kudos from several commissioners for offering up-front certainty to industry participants.

As for the second major problem with short-term mitigation, Simon questions why a market participant would sign a long-term forward contract to hedge risk at a price, when the participant can buy in the real-time spot market at a mitigated price below that.

What’s resulted is the “ultimate death spiral” where mitigation happens below the price of entry, she said. That, in turn, “doesn’t permit people to enter these markets, which in turn creates problems, which is then mitigated for political reasons.”

Simon said that FERC’s recently unveiled standard market design (SMD) for U.S. wholesale power markets could fuel this death spiral. “The mitigation that it integrates into these markets, if it isn’t fixed, if we continue to mitigate below price of entry, it’s going to continue a very serious death spiral.”

Meanwhile, the EPSA official said that the amount of announced capacity is declining in the U.S. “We are not in a situation where nobody’s building. What we’re seeing is that the rate of growth has slowed dramatically.”

EPSA has set up a nationwide matrix that tracks new power project development, which is available for searching at the association’s web site (www.epsa.org). “What we have seen for about the first three years we did the matrix was that every single time we did it, the number was bigger and bigger and bigger. Now we’re starting to see the number come down a little bit.”

As for access to capital for the power industry, Simon said that the sector has been “hit very hard” and has lost billions of dollars in capitalization. “Some people ask if we’ve hit the bottom yet. I don’t know. Maybe, but maybe not.”

She noted that concerns have been raised over the billions of dollars worth of so-called “mini-perm” construction financing debt that is coming due for the power industry in the next year or so. Indeed, Standard & Poor’s recently issued a report in which the ratings agency said that it views the refinancing of this type of debt as one of the largest risks currently facing energy merchants.

“I think it still remains to be seen whether the industry is going to be able to pull itself together,” Simon said. “I think a lot of people figured that over time there would be some natural consolidation. That some companies would make dumb decisions, other companies would make better decisions and the invisible hand of the markets would squeeze the dumber ones and they’d get bought by the bigger ones.” But the reality is that “everybody’s getting squeezed at the same time.”

What’s left unsettled is whether “everybody’s going to kind of come out of the squeezing and be smaller, tighter leaner but the same number or eventually are there going to be acquisitions or are there going to be new entrants? Are we going to see more of the banks and more of the European companies starting to come into these markets? Those are all open questions.”

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